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Credit Cards: How They Work and How to Use Them to Your Advantage

  • April 23, 2014
  • By Grace
Credit Cards: How They Work and How to Use Them to Your Advantage

Credit card debt around the world is getting out of control.  But despite what many people think, credit cards aren’t the tool of evil banks trying to steal all your money.  Credit cards can be useful and beneficial if you know how to use them to your advantage.

What is a credit card?

A credit card is basically a pre-approved, fluid loan.  You use the card to borrow money, and you must pay it back later.  For some people, though, it’s all too easy to rack up the charges and get in over their heads in debt.  If you can’t pay back the debt quickly, you’ll end up in real financial trouble.


How do I get a credit card?

Almost anyone can get a credit card.  You can apply for one online, but mostly the credit card companies send out letters saying that you’ve been ‘pre-approved’ for a card.  This means nothing, because nearly everyone qualifies for a credit card.

However, not all people qualify for the same credit cards.  People with good credit are offered cards with high credit limits and low interest rates.  People with bad credit or no credit are offered cards with low credit limits and high interest rates.

What are interest rates?

The interest rate, or APY (which stands for ‘annual percentage yield’), is a fee paid for borrowing money.  When you open a savings account at a bank, the bank pays you interest for allowing them to hold onto it; you are, essentially, lending money to the bank that you can get back at any time.  You want a bank account with a high interest rate, so that you make more money.

When you borrow money with a credit card, however, you pay interest to the credit card company.  (Some cards with good rewards or perks may charge a yearly fee, but that’s a flat rate and is separate from interest.)  You want a credit card with a low interest rate, because the bank will make less money from you.

Interest is how credit card companies make most of their money.  When you have a balance on your credit card for more than a month, that balance accumulates interest.  It’s best to pay off the full balance of your card every month.  If you pay the full balance each month, you’ll never pay interest!


What if I only make the minimum payment each month?

Say you have a $2000 balance on a card with an 18% interest rate.  In a one-month period, you’ll accumulate $30 in interest.  Any payment you make goes toward interest first, then your principal balance (they money you actually borrowed) second.  If your minimum monthly payment is $50, then the first $30 of that will go to paying interest and the leftover $20 goes toward paying your balance.  If you only made the minimum payment each month, it would take you over 15 years to pay off the balance, and you’d end up paying almost $4500 total—the interest would cost you more than the original debt!

Interest builds up quickly.  Even if you have a very low-interest credit card, it’s still best to pay off the full balance every month.

What are the problems with credit cards?

The main problem with credit cards is that many people don’t understand that keeping a balance means you’re going to pay a lot of money.  It’s also a vicious cycle: people who are uneducated about credit tend to have poor credit, which means they have higher interest rates, and end up owing more money.  Poor people are also less likely to be educated about credit, but are more likely to need credit cards to pay for things they can’t currently afford, such as food and bills between paydays.  Poor people may also have more difficulty making their payments on time.  In these cases, it can seem like credit card companies are taking advantage of the financially desperate.

If you find yourself in a financially desperate situation, credit cards are not the answer.  While they can provide easy and quick access to money you don’t have, using a credit card in this way can destroy your credit for the rest of your life.  Try to find help in other places first, such as family members or charitable organizations.

How can I use a credit card to my advantage?

Credit cards can be a useful tool in building good credit, assuming you make your payments on time.  Many also offer useful rewards, such as airline miles or cash back, which can save you money.  But like any tool, credit cards can hurt you if used irresponsibly.

Most people, especially new credit card holders, don’t realize is that it’s actually very easy to avoid paying interest!  All you need to do is pay off the entire balance each month.  If your charges don’t stay on the card for more than a month, you don’t pay any interest.  You’ll only pay back the money you borrowed, and no extra.

Avoid large purchases on your credit card if you cannot pay it off immediately.  Purchases like furniture, electronics, and health services (such as dentistry and elective surgeries) can often be financed through low-interest or no-interest options, so make sure to ask before you pay with your credit card.


By Grace, April 23, 2014
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